5

Income Inequality

To begin to understand what life is like Russia, although somewhat higher. But
in a country—to know, for example, the incidence of poverty is slightly lower
how many of its inhabitants are poor— in Hungary than in Russia, while in
it is not enough to know that country’s Brazil it is much higher than in either of
per capita income. The number of the other two. These observations can
poor people in a country and the aver- be explained with the help of Figure
age quality of life also depend on how 5.1, which shows the percentages of
equally—or unequally—income is national income received by equal per-
distributed. centiles of individuals or households
ranked by their income levels. In
Hungary the richest 20 percent (quin-
Cross-country Comparisons of tile) of the population receives about 4
Income Inequality times more than the poorest quintile,
while in Brazil the richest quintile
In Brazil and Hungary, for example, receives more than 30 times more than
GNP per capita is close to that in the poorest quintile.

Figure 5.1 Income distributed by population quintile

in Brazil, Russia, and Hungary

Brazil, 1989 Russia, 1993 Hungary, 1993

Richest 20%
of population 67.5 53.8 36.6

Second 20% 16.8 20.4 22.3

Third 20% 8.9 13.5 17.6

Fourth 20% 4.9 8.5 14.0

Poorest 20% 2.1 3.7 9.5

0 20 40 60 80 0 20 40 60 80 0 20 40 60 80
Percentage of total income Percentage of total income Percentage of total income

24
 5 INCOME INEQUALITY

In Russia the ratio of income received by
the richest quintile of the population to
that of the poorest quintile was about 14:1
in 1993 and was growing because of mar-
ket reforms and the transition crisis.
Compare that ratio to an average of
about 6:1 in high-income countries. In
the developing world income inequality,
measured the same way, varies by region:
it is 4:1 in South Asia, 6:1 in East Asia
and the Middle East and North Africa,
10:1 in Sub-Saharan Africa, and 12:1 in
Latin America.
Lorenz Curves and Gini Indexes
To measure income inequality in a coun-
try and compare this phenomenon
among countries more accurately, econo-
mists use Lorenz curves and Gini
indexes. A Lorenz curve plots the cumu-
lative percentages of total income
received against the cumulative percent-
ages of recipients, starting with the poor-
est individual or household (Figure 5.2).
How is it constructed?
First, economists rank all the individuals
or households in a country by their
income level, from the poorest to the
richest. Then all of these individuals or
households are divided into 5 groups (20
percent in each) or 10 groups (10 per-
cent in each) and the income of each
group is calculated and expressed as a
percentage of GDP (see Figure 5.1).
Next economists plot the shares of GDP
received by these groups cumulatively—
that is, plotting the income share of the
poorest quintile against 20 percent of
population, the income share of the

Figure 5.2 Lorenz curves and Gini indexes for Brazil, Russia, and Hungary

Percentage of total income

100 Hungary
(Gini index = 27.0%)

Russia
80 (Gini index = 49.6%)
ity

Brazil
ual
eq

60 (Gini index = 63.4%)

te
lu
so

Line of absolute
ab
of

inequality
40
ne
Li

20

0
0 20 40 60 80 100

Percentage of total population

Poorest Richest

25
THE WORLD AND RUSSIA
poorest quintile and the next (fourth)
quintile against 40 percent of popula-
tion, and so on, until they plot the
aggregate share of all five quintiles
(which equals 100 percent) against 100
percent of the population. After con-
necting all the points on the chart—
starting with the 0 percent share of
income received by 0 percent of the
population—they get the Lorenz curve
for this country.
The deeper a country’s Lorenz curve, the
less equal its income distribution. For
comparison, see on Figure 5.2 the
“curve” of absolutely equal income dis-
tribution. Under such a distribution pat-
tern, the first 20 percent of the
population would receive exactly 20 per-
cent of the income, 40 percent of the
population would receive 40 percent of
the income, and so on. The correspond-
ing Lorenz curve would therefore be a
straight line going from the lower left
corner of the figure (x = 0 percent, y = 0
percent) to the upper right corner (x =
100 percent, y = 100 percent). Figure
5.2 shows that Brazil’s Lorenz curve
deviates from the hypothetical line of
absolute equality further than those of
Hungary and Russia. This means that
among these three countries, Brazil has
the highest income inequality.
A Gini index is even more convenient
than a Lorenz curve when the task is to
compare income inequality among many
countries. The index is calculated as the
26
area between a Lorenz curve and the line
of absolute equality, expressed as a per-
centage of the triangle under the line
(see the two shaded areas on Figure 5.2).
Thus a Gini index of 0 percent repre-
sents perfect equality—the Lorenz curve
coincides with the straight line of
absolute equality. A Gini index of 100
implies perfect inequality—the Lorenz
curve coincides with the x axis and goes
straight upward against the last entry
(that is, the richest individual or house-
hold; see the thick dotted line on Figure
5.2). In reality, neither perfect equality,
nor perfect inequality is possible. Thus
Gini indexes are always greater than 0
percent but less than 100 percent (see
Figure 5.3 and Data Table 1).
Costs and Benefits of Income
Inequality
Is a less equal distribution of income good
or bad for a country’s development? There
are different opinions about the best pat-
terns of distribution—about whether, for
example, the Gini index should be closer
to 25 percent (as in Sweden) or to 40 per-
cent (as in the United States). Consider
the following arguments.
An excessively equal income distribution
can be bad for economic efficiency.
Take, for example, the experience of
socialist countries, where deliberately
low inequality (with no private profits
and minimal differences in wages and
 5 INCOME INEQUALITY

Figure 5.3 Income inequality in selected countries, various years

Gini index (percent)

70
63%
60 56% 58%
48% 50% 50%
50
Average for middle-income countries, 1989
40% 41%
40 Average for OECD countries, 1989 33%
27% 28%
30 25% 26%
20% 22%
20

10

0
92 .

19 en

19 any
19 rus

19 ine

19 nd

ni 19 nce

19 tes

19 sia

19 ssia

ne 992 o

19 sau
19 ep

19 ina

19 nya

89 l
19 azi
1 ic
ed

U 2

89
Sw93

92

G 92

d 9

94

89

91
la

ay
R

93
M 95

92
a

ex
la

Ch

s
m

a
9

Br
Ke
te 8

Ru
St

Bi
kr

Po
ak

Fr
Be

al

M
er

a-
ov
Sl

ui
U

G
Note: An index value of 0 percent represents absolute equality in income distribution; 100 percent represents absolute inequality.

salaries) deprived people of the incen- ple are dissatisfied with their eco-
tives needed for their active participation nomic status, which makes it harder
in economic activities—for diligent to reach political consensus among
work and vigorous entrepreneurship. population groups with higher and
Among the consequences of socialist lower incomes. Political instability
equalization of incomes were poor disci- increases the risks of investing in a
pline and low initiative among workers, country and so significantly under-
poor quality and limited selection of mines its development potential (see
goods and services, slow technical Chapter 6).
progress, and eventually, slower eco- • High inequality limits the use of
nomic growth leading to more poverty. important market instruments such
as changes in prices and fines. For
On the other hand, excessive inequality example, higher rates for electricity
adversely affects people’s quality of life, and hot water might promote
leading to a higher incidence of poverty energy efficiency (see Chapter 15),
and so impeding progress in health and but in the face of serious inequality,
education and contributing to crime. governments introducing even
Think also about the following effects of slightly higher rates risk causing
high income inequality on some major extreme deprivation among the
factors of economic growth: poorest citizens.
• High inequality may discourage cer-
• High inequality threatens a country’s tain basic norms of behavior among
political stability because more peo- economic agents (individuals or
27
THE WORLD AND RUSSIA
enterprises) such as trust and com-
mitment. Higher business risks and
higher costs of contract enforcement
impede economic growth by slowing
down all economic transactions.
28
These are among the reasons some inter-
national experts recommend decreasing
income inequality in developing coun-
tries to help accelerate economic and
human development.